Mexico Opens Energy Sector to Private Investors

MEXICO CITY—Mexican lawmakers late Wednesday completed an historic opening of the country’s energy sector to private investors after 76 years of state monopoly, in a move with far-reaching implications for the sector and the country’s economy.

Completion of the overhaul is a political victory for President Enrique Peña Nieto, who made it the cornerstone of a reformist agenda intended to improve Mexico’s competitiveness and stimulate economic growth. The victory seemed unthinkable to many when he took office in December 2012. Over the past quarter century, every Mexican president had tried but failed to secure political support to diminish the state energy monopoly.

The opening of the energy sector is the culmination of a decades-long effort to liberalize the Mexican economy that began in 1982, when then-President Miguel de la Madrid took the first steps toward ending decades of state control. Energy had remained as the one important economic sector still in state hands.

The legislation, which implemented constitutional changes passed in December, goes now to Mr. Peña Nieto, who is expected to sign it into law in the coming days.

Under the new law, foreign and private domestic energy companies will be able to explore, produce and refine oil for the first time since Mexico nationalized its oil industry in 1938 and transformed oil into a symbol of national pride. State-owned oil giant Petróleos Mexicanos, or Pemex, was created that year, and has since been the only company allowed to exploit the country’s oil and gas resources, turning Mexico into the world’s ninth-largest oil producer.

The sector’s liberalization is expected to attract billions of dollars in new investment, increase oil and gas production, lower electricity costs and make Mexico’s industry more competitive.

“This is a new, important step in that same direction of creating markets. Transforming the energy sector into an energy market should lower power costs and Mexico’s industry would be unstoppable against China and even the U.S.,” said Luis de la Calle, an economic consultant and a former Mexican trade official.

Critics, mainly from the political left, argue that the reform is a death sentence for Pemex, will result in fewer oil dollars for Mexico, and amounts to a loss of national sovereignty.

Mexican senators in session in Mexico City on Wednesday. Bloomberg News

Under the new framework, Mexico private oil and gas firms will operate under contract with the Mexican state, competing with Pemex. The changes allow for production-sharing contracts and licenses, and companies will be able to book reserves as expected income. Before the reform, private firms only were able to work for Pemex under service contracts.

“We have a great opportunity to start creating in Mexico a business fabric of private oil and gas operators. Mexico has hundreds of service companies that now will be able to explore for oil,” said Telésforo Segura, the head of a mid-sized Mexican service contractor which has worked for Pemex for years. Among foreign companies, Japan’sMitsui8031.TO -2.13% & Co. and U.S.-based Chevron Corp. CVX +1.76% have already expressed interest in investing in Mexico.

Mexico is also believed to have the world’s sixth-largest reserves of shale gas, natural gas that is trapped in rock formations. New methods that permit the extraction of oil and natural gas from such formations have revolutionized the U.S. energy market in recent years.

The challenge now for Mr. Peña Nieto is to implement the reform well.

“The success of the energy reform will be dictated by the attractiveness of the fiscal terms to be set in place. Mexico is aware of the need to strategically position itself with competitive government-take levels to attract investment,” analysts at Houston-based energy consultancy firm Wood Mackenzie said in a note.

In the coming weeks, attention will focus on the oil and gas fields that Pemex will be directly assigned as part of a “round zero” before tenders are launched for private participation.

The Energy Ministry is expected to decide by mid-September. Pemex has requested to keep almost all areas already under production and a third of prospective resources, such as potentially massive undiscovered offshore oil deposits, although it will likely get less than it wants.

The first tenders for joint-venture projects at fields already assigned to Pemex are expected later this year. Bidding for new areas is expected to take place by June 2015. The government wants to organize at least one public tender a year until Mr. Peña Nieto’s current administration ends in 2018.

The stakes are high for the president. He has promised that electricity tariffs for consumers would decline within two years as a result of competition and investment in the energy sector, and that oil output would rise by 20% to 3 million barrels a day in 2018. By that time, the government hopes, investment in the energy sector will have doubled to around $60 billion a year.

Despite the promises, the Mexican people appear divided over energy reform. In a recent poll by Mexican newspaper Reforma, 40% of Mexicans said the changes would be bad for the country.

Many leftist politicians and Pemex insiders warn that the state energy giant will be unable to compete with private companies, which they say could lead to the dismantling of the company in the medium term.

“The goal to attract private investment has been put above the necessity of making sure that Pemex will continue to be the dominant player in Mexico’s oil industry,” said Fluvio Ruiz, a Pemex board member.

The Party of the Democratic Revolution, Mexico’s main leftist party, is trying to organize a referendum to undo the changes, warning that Mexico could obtain less oil money if the reform is badly implemented, or if the terms are too generous to private firms.

The government denies claims that its goal is to weaken Pemex, arguing that the new laws give the company sufficient operating autonomy to be able to compete.

Under the new legislation, the government could absorb a part of the company’s $84 billion in pension-related debt, a huge burden, on the condition that Pemex management and the oil workers union agree to new, more flexible pension rules.